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China’s Logistics Network: A Brief Introduction

Smith, Reginald and Zhu, Nan and Wang, Long

Bouchet-Franklin Institute, Southwestern University of Finance and Economics

30 November 2008

Online at https://mpra.ub.uni-muenchen.de/11993/ MPRA No. 11993, posted 15 Dec 2008 07:26 UTC ’s Renminbi Currency Logistics Network: A Brief Introduction

Reginald D. Smith

Bouchet-Franklin Institute, P.O. 10051, Rochester, NY 14610, USA

Nan Zhu

The MBA Education Centre, Southwestern University of Finance and Economics, P.O.Box 610074, , China

Long Wang Chengdu Branch of People’s of China, P.O.Box 610041, Chengdu, China; School of Business Administration, Southwestern University of Finance and Economics, P.O.Box 610074, Chengdu, China

Abstract Currency logistics is becoming a field of increasing interest and importance both in government and academic circles. In this paper, a basic description of China’s nationwide logistics network for the Renminbi is discussed and analyzed. In addition to its basic structure, its key problems such as production costs, inventory levels, and transportation and storage are discussed. Key words: currency supply chain, China’s Renminbi currency, logistics management

Oftentimes, discussions of or the basic supply measure, M0(cash in circulation), is only the realm of macroeconomic theory and . As valuable as these insights are, even in our increasingly digital economy, cash is still largely a physical . In almost all nations, physical cash and are backed, minted or printed, and supplied by a in cooperation with government and commercial and businesses across the country. As has been discussed by Rajamani et. al. [1], Geismar, et. al. [2] and the [3], the nature of the logistics and physical distribution of ‘cash supply chains’, ‘cash chains’, or ‘currency chains’ is still largely untouched in the published with the exception of discussions

Email addresses: [email protected] (Reginald D. Smith), [email protected] (Nan Zhu)

Preprint submitted to Elsevier December 14, 2008 of institutional cash management. The central of every nation, and those of supranational monetary authorities such as the European Central Bank (ECB), face the clas- sic supply-demand and distribution issues that face any businesses or when distributing goods. Among the most important decisions are to with a public or private and bureau to produce currency, ascertain the demand for cash both within and outside of the country, how to handle the physical notes and coins based on this demand and the financial and business sector framework, the extent of public or private management of the distribution and cash warehousing network, security in this distribution network, recircula- tion of and coins back to a central authority where obsolete and debilitated currency can be removed from circulation, and how to effectively cut out currency from the supply chain. A useful framework of the cash supply chain as a closed-loop supply chain where both forward distribution and reverse logistics are considered was dis- cussed in [1]. As seen in Figure 1, there is a forward and backward motion of notes throughout the supply chain as notes are distributed to the public and notes are take back for sorting and many are removed from circulation. Schautzer [4], Carlin [5], and the Reserve Bank of India [6] discuss the cash supply chains of in the context of the EU, , and India re- spectively. Each of these countries has a system of logistics that is fit to its individual circumstances. In Austria’s case, like other countries, both the national central banks and the ECB work together to determine demand, production, and distribution across the Eurozone.

1. China: Economy and Institutions

The People’s Republic of China has undergone a rapid and massive trans- formation since 1978 when its economic liberalization began. China has now become the world’s fourth largest economy, with an estimated 2008 GDP of $3.6 Trillion according to estimates, and has undergone double digit annual growth for the last several years. Having the world’s largest popu- lation of 1.4 billion people, it unsurprisingly has the largest volume circulation of banknotes in the world [8]. The Chinese currency, the Renminbi (RMB), is non-convertible and man- aged by the People’s (PBOC), the Chinese central bank. It is throughout but not Kong S.A.R., S.A.R. or which will not be covered in this paper. Table 1, lists the and note denominations in the current fifth series of banknote styles which began rollout in 1999 and completed rollout in 2005 [10]. Figure 2 also shows a sample banknote, the 100 RMB denominated note. The official responsibility of cash currency policy given to the PBOC is laid out in the “People’s Bank of China Law, The People’s Republic of China” guidelines [10]. In addition, the current monetary policy is outlined in the PBOC’s“Monetary Policy” doc- uments available on its website [10]. Like most modern , the RMB

2 Figure 1: Basic structure of a closed-loop currency supply chain.

3 Figure 2: 100 RMB note design.

Coins (in“”) Notes (in“yuan”) 0.1 1 0.5 5 1 10 20 50 100

Table 1: Current fifth series Renminbi coin and banknote denominations. has evolved over time in order to increase durability and has added a variety of anti-counterfeiting measures to the note.

2. China’s Currency Circulation, Denominations, and Structure

China has had to deal with an exponentially growing during its period of rapid growth over the last few decades. In Figures 3 and 4 are M0 statistics from China over time. Figure 3 shows annual year-end M0 since 1978 and Figure 4 shows monthly M0 since December 1999. M0 has grown from 21 billion RMB in 1978 to over 3 trillion RMB at present, a 147-fold increase [10, 12]. Though the monetary policy aspects of this are widely discussed and debated, it presents a massive logistical challenge which would require a co- committed expansion in production, infrastructure, and distribution capabilities to prevent shortages.

4 Figure 3: Annual M0 by year from 1978 to October 2008.

Figure 4: Monthly M0 from December 1999 to October 2008. Annual spikes are due to increased withdrawals and circulation due to gift giving and purchases on the holiday.

5 1978 1987 1988 1998 1 & 2 RMB 16% 5% 5% 2% 5 RMB 30% 16% 16% 1% 10 RMB 49% 72% 48% 7% 20 RMB 4% 7% 8% 2% 50 RMB N.A. N.A. 13% 13% 100 RMB N.A. N.A. 11% 75% All coins 1% 1% N.A. N.A.

Table 2: Percent of M0 each banknote represents by year; 20 RMB was calculated using a plug for 100% since numbers were not given. 10 RMB in 1988 estimated based on percent in 1987 minus capture from 50 and 100 RMB. See Chen [14], Guo [12]

1978 1987 1988 1998 1 & 2 RMB 48% 22% 26% 38% 5 RMB 28% 24% 27% 8% 10 RMB 23% 52% 41% 20% 20 RMB 1% 2% 3% 3% 50 RMB N.A. N.A. 2% 8% 100 RMB N.A. N.A. 1% 23%

Table 3: Percent of total banknote volume each represents by year; calculated using 1.5 used for of 1 and 2 RMB set. See Chen [14], Guo [12]

A brief ’s cash policy until 1998 is given in [12] which divides the growth of the cash culture in China into three phases: 1978-1980, 1981-1984, 1985-1988, 1989-1993, 1994-1997 based largely on the increases of the average yearly net increase in M0 in each period. China’s money supply as expected has largely increased due to the increasing needs of societal transactions, rises in consumer prices, and policies effect on the money supply. Chinese currency denominations have changed from the first series to the current fifth series of banknotes. The general structure of the banknote compo- sition of the money supply has changed with the needs of society as mentioned in [12]. In Tables 2 and 3, are the % of M0 in RMB and volume for the years 1978, 1987, 1988, and 1998. Consistent with most economies, the largest vol- ume of bills are of small denominations which is necessary in order to produce change and allow small transactions. There have been some large changes in the structure of RMB denominations as the 50 and 100 RMB notes have taken huge share from the 5 and 10 RMB notes since their introduction in the 1987 and 1988 respectively. This is likely, in part to the increasing use and acceptance of ATMs as well as rising demand for high value cash transactions. Guo [12] fur- ther predicts that the 100 RMB note will continue to hold a large share, 80%+ of M0 by value out until 2010. Guo also predicts the PBOC may eventually choose to introduce a 500 and 1000 RMB note though this is speculative.

6 Figure 5: Location of banknote printing facilities and mints in China. Blue circles are mints, green circles are banknote printers, and red circles are note paper producers. China map image courtesy Wikimedia author Rich4.

3. China’s Currency Management and Distribution

According to the “People’s Bank of China Law, The People’s Republic of China” the PBOC is responsible for determining how RMB are produced (Zhu and Wang[9]). The actual infrastructure for the minting/printing of Chinese currency is carried about by a owned corporation, China Banknote Print- ing and Minting (CBPMC) headquartered in . CBPMC uses a network of printing and and minting facilities around the country (see Fig- ure 5) to produce banknotes and coins for subsequent distribution. Banknote printing facilities are based in Beijing, , Chengdu, Xi’an, , and . Mints are located in , Shanghai, and . Also, high grade paper for the banknotes is produced at two facilities in and Kunshan. The Baoding facility is the largest facility in the world dedicated to developing banknote material [11]. In addition, the PBOC has its own print- ing research division which researches new techniques for creating banknotes and making counterfeiting more difficult. Chen [7], Zhang [8], and Zhu & Wang [9] detail the distribution and logistics

7 network of the RMB throughout China. In Figure 6, is a diagram of the - nese cash supply chain based on [14]. Banknotes and coins are first forwarded to a central distribution center from which they are distributed to regional and provincial distribution centers. These subsequently feed into regional“central distribution centers” which feed local level payment distribution cen- ters and commercial banks. Finally, these banks distribute the banknotes and coins to businesses and the public through withdrawals and financial transac- tions. About 80% of the cash currency is in the hands of citizens divided roughly between cities and rural areas as 25% to 75% [14]. The reverse logistics portion of the chain is similar where the public deposits notes in banks which forward the bills to local or central payment distribution centers. At the central pay- ment distribution centers or regional distribution centers the bills and coins are sorted, unfit or counterfeit bills and coins are removed from circulation, and subsequently sent to be destroyed. There is no reverse flow of currency back to the central distribution center. As of 2005, throughout the entire distribution network, there is one cen- tral distribution center, 15 regional distribution centers, and 32 provincial dis- tribution centers. For the payment distribution centers there are 335 central payment distribution centers and 1,393 local payment distribution centers na- tionwide [8] for a total of 1,775 currency-related distribution centers. Though the exact volumes are not known, it is likely the largest volumes of banknotes are transported to the four prominent state-owned banking institutions, the Bank of China, , China Industrial , and China Agricultural Bank. Safety reserve () levels within the distribution system are typically very high compared to other countries. According to [9], safety reserve requirements dictate that enough currency to satisfy at least 24 months of currency issuing demand must be on stock at all times, though which levels of distribution this is mostly held at is unclear. At this level, there would only be 1/2 of a turn of currency stock per year on average. Given the net in- crease in M0 over 2007 was 652 billion RMB (about $80 billion USD) this would imply that safety would be massive to keep up with such high demand. Currency maintained within the central and regional distribution centers is both cycle and safety stock which is not considered in circulation. These distribution centers funnel money out to the commercial banks and businesses theoretically using a FIFO system (though this is not always consistent) [8]. Under a FIFO queuing system, the average bill or coin would spend almost two years in reserve stock before entering circulation. They report this safety reserve level as being twelve times higher than the typical standard in Western devel- oped nations. Despite these regulations, inventory management in currency warehouses and distribution centers is still not standardized and is in need of continued modernization and the use of advanced information technology. In regulations established in 1988,“Provisional Regulations on Cash Man- agement” and“Detailed Implementation Regulations for Cash Management”, the PBOC has declared that it is the responsibility of each bank or division to be responsible for the transport and security of the physical currency it receives and transports. Therefore, distribution centers and commercial banks either

8 Figure 6: China’s currency chain according to Chen [14]. Dotted lines indicate reverse flows of currency.

9 use their own armored cars and hire their own security and handling person- nel or outsource this to a third-party. This trend, beginning in 1996 with the establishment of a private company in Shanghai, has continued to accelerate so that in 2004, there were at least 130 professional armored car services across the country. In the developed cities such as Beijing, Shanghai, and , these third party logistics providers also have their own vaults. However, in smaller cities and developing regions these providers often do not have their own vaults and the banks are often in charge of the risk of storing, protecting, or even transporting cash. From the observation of the authors, about 30% of bank personnel are involved in transporting or storing cash. Sim- ilar observations put personnel relating to the functions of security and cash management at up to 1/3 of all employees (Yang [13], Zhu and Wang [9]).

4. Risks and Problems

4.1. Reverse Logistics and Currency Destruction Reverse logistics, being one of the most important facets of the currency process, is an area of intense research in the Chinese currency chain. First, the ratio of returned currency to issued currency is high, averaging 68% per year from 1993-2003 [14]. There are two main reasons. One reason is for banks to return currency for sorting is not just to remove unfit currency but to take the storage and possibly non-interest earning currency off of their and send it to the central bank which would pay them interest on deposited currency. Another reason is that following PBOC guidelines, the PBOC sets and ratifies quotas on the amounts of cash on hand in the vaults at commercial banks. If a bank exceeds its cash quota, it must return the excess to the PBOC. Since not all of this currency is unfit and destroyed, it indicates that it is likely the PBOC or CBPMC subsidize the storage and operations of bill and coin sorting and re-issuing. Many nations, including the and Australia, have begun to outsource this non-core process further down the currency chain to commercial banks or charge a fee so that such large volumes of currency will not be returned for sorting [2, 5]. Some nations such as have already privatized the entire process [1]. The ratio of unfit bills, however, is so large it necessitates the return of such large volumes of currency for sorting. The amount of unfit currency which is destroyed each year is usually about 30% of that years issue (Chen [14], Zhu and Wang [9]) giving currency an average life of only 3 years. Reverse logistics of currency, both cleaning and destruction, are among the greatest challenges fac- ing China’s currency chain. In a 2005 report on the PBOC website [15], Chen Baoshan, an expert at the PBOC who has worked in both currency logistics and anti-counterfeiting and has written many of the standard texts on currency logistics in China, gave statistics on the growing issues in the reverse logistics of the RMB. In 2004, China sorted 7.92 billion banknotes, a 46% jump from the previous year. Also, 15,000 metric tons of RMB were destroyed as being unfit or obsolete currency. This was in fact only 58% of all currency destroyed

10 nationwide (natural processes, manual destruction) so the actual amount of de- stroyed currency amounted to 26,000 metric tons. By the end of 2004, there was a nationwide network of 20 cash handling centers who purchased an additional 45 currency sorting and 5 currency destruction machines bringing the nationwide total to 310 currency sorting machines and 67 currency destruction machines. According to [8] each currency sorting costs about 1 million RMB to purchase and about 300,000 RMB per year to maintain. Each currency destruction machine costs about 18 million RMB. This puts the total purchases for reverse logistics by the PBOC at about 135 million RMB (about $20 million USD). Many of the unfit bills, though it is not clear how much, are due to coun- terfeits, especially in the high denominations. In addition, Chinese banknotes apparently have a propensity to grow fungus over time. In [9], it is said about 180,000 banknotes of total unknown value had to be removed because of fungal damage. It is unknown how much of this process will eventually be outsourced or updated in the future, however, unless the number of unfit and counterfeit bills can be reduced, the challenges of reverse currency logistics will only continue to increase.

4.2. High Production and Transport Costs The recent, and mercifully brief, commodity price boom brought attention to the possibility of many coins around the world of having negative due to costs of production and transport per weight being more than the of the coin. According to [8] this has been an issue for China since at least 2005. He states that for the (10 /) coins and the 1 jiao note the production costs had already exceeded the face values. The 1 RMB coin and the 2 jiao banknote (fourth series) production costs were roughly equal to the face value. Given the 6.05g weight of the 1 RMB coin given by the CBPMC, it can be estimated that minting production costs for coins are roughly 0.165 RMB/g. Given the 1 jiao and 5 jiao coins weigh 2.2g and 3.8g respectively their estimated production costs could be 0.36 RMB(3.6 jiao) and 0.63 RMB (6.3 jiao) showing the magnitude of the problem with these small coins. Similarly with the jiao notes, if a 2 jiao note was roughly breakeven and has a dimension of 120x55 mm then the cost per mm2 is about 3x10−3 jiao per mm2 and with a 1 jiao note of dimensions 115x52 shows a production cost of 0.18 RMB (1.8 jiao). It is plausible that during the recent commodity boom, even the 1 RMB coin and possibly some of the RMB banknotes had negative seigniorage.

4.3. Transport and Storage Security Risks Security of currency transport as discussed earlier, is the responsibility of lower level recipients and distributors and not the PBOC. This throws into relief the fact that risks for transportation security can often be on weaker members of the currency chain. Given the lack of standardization or highly qualified outsourced vendors for this process, security and safety of currency transport is a continuing issue. [8, 9] both mention a sharp rise in currency

11 and heists in recent years. In 2006, there were 26 cases of armed holdups and 31 of bank or currency. For example in November 2006 in province’s Yicheng , 2.6 million RMB (about $325,000 USD) was stolen from currency being transported from a payment distribution center. In 2007, in province’s rural currency distribution warehouse, a theft of almost 51 million RMB (about $7.3 million USD) occurred. The security of transporting and storing currency is an increasingly urgent problem, especially with the explosive growth of the money supply and will be a key issue for the future.

5. Concluding Remarks

As one of the currencies with growing importance in the world financial sys- tem, the efficiency and effectiveness of the RMB logistics system will impact not only China but the rest of the world. This impact will likely become more marked at the point in the future that China decides to allow full for the RMB and more open capital flows. RMB are already present in signif- icant quantities in neighboring states such as and the Central Asian states due to burgeoning [16]. It is too early to say whether physical RMB will become a major regional or even global currency on full convertibility but it is sure this event will emphasize the even greater need for modern logistics management. More efficient transportion and inventory policies will allow lower safety stock levels as well as possibly lower rates of unfit bills. In addition, possibly moves like other countries to outsource or privatize a segment of the operations could take a great weight off the hand of the PBOC and CBPMC to allow more focus on the production aspects and lower the amount of sorting required. It seems, however, that Chinese government officials and academics have taken this problem to heart and are working for successful solutions. Earlier frac- tional currency shortages such as those in and in 1994 [9] are increasingly less common though they are still occuring. Indeed, the author found more academic articles and full books on currency logistics in the Chi- nese literature than the English language academic literature. Therefore such a mainstream and studied subject will most likely soon both improve China’s own currency logistics and provide successful examples to the rest of the world.

References

[1] Rajamani, Divakar, Geismar, H. Neil, & Sriskandarajah, Chelliah “A frame- work to analyze cash supply chains”, Production and Operations Manage- ment, vol. 15, no. 4, p.1-9, 2006. [2] Geismar, H. Neil, Dawande, Milind, Rajamani, Divakar & Sriskandarajah, Chelliah“Managing a Bank’s Currency Inventory Under New Federal Re- serve Guidelines”, Manufacturing and Service Operations Management, vol. 9, no. 2, p.147-167, 2007

12 [3] European Central Bank, “Evaluation of the 2002 Cash Changeover”, Frank- furt, Germany, April 2002

[4] Schautzer, Anton,“Cash logistics in Austria and the Euro Area”, Oester- reichische Nationalbank’s Monetary Policy and the Economy, first quarter, p.138-149, 2007 [5] Carlin, Peter,“Currency note processing and distribution arrangements in Australia”, presented at Currency Conference, 2004 [6] Chapter 8: Currency Management, “Annual Report 2007-08”, Reserve Bank of India, New Delhi, August 2008 [7] Chen, Baoshan,“A basic examination of cash logistics”, Finance , no. 5, p.21-24, 1998. (in Chinese) [8] Zhang, Lele,“An analysis of the current state of China’s currency logistics”, Logistics Techniques and Uses, no. 3, p.92-95, 2005 (in Chinese) [9] Zhu, Nan & Wang, Long,“A basic investigation of China’s banking industry cash logistics management,” Modernization of Management, no. 6, p.18-20, 2007. (in Chinese)

[10] People’s Bank of China, website http://www.pbc.gov.cn [11] CBPMC Badoing Facility Website http://www.cbpmc.com.cn/ssqy/bdyc/gyqy qygk.htm [12] Guo, Ju’,“A forecast of the demand for Renminbi cash quantities and structures”, Modern Economic Science, vol. 22, no. 1, p.23-29, 2000. (in Chinese)

[13] Yang, ,“Difficulties in financial transportation”, China Business, 28 Jan- uary, 2003 (in Chinese) [14] Chen, Baoshan, Cash Currency Theory, Higher Education Publishing, Bei- jing, p.36-59, 2004 [15] Chen, Baoshan, “Physical currency issuing”, People’s Bank of China, June 10, 2005, retrieved November 25, 2008, http://www.pbc.gov.cn/detail frame.asp?col=1732&id=9307&keyword=&isFromDetail=1

[16] Liu, Zonghua, , Haigang, Xu, Fang, “Research on the question of Ren- minbi circulation outside of China”, Journal of College Financial Management Cadres, no. 3, p.5-7, 2003.

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